Recession CEOs: Cautious Revenue-Generators

New research suggests that nurture may be more important than nature when it comes to how CEOs manage businesses. According to a working paper by Massachusetts Institute of Technology professors Antoinette Schoar and Luo Zuo, published by the National Bureau of Economic Research, economic conditions at the time a CEO enters the labor force make a strong and lasting impression on their managerial styles.

The authors collected information on the career paths of business leaders from 1,500 large publicly traded U.S. companies over an 18-year span through 2007. They found that CEOs who started during recessions were more cautious than those who took over during expansions. Specifically, Schoar and Luo determined that chief executive officers whose careers began during recessions spent less on research and development, took on less debt, diversified more broadly and slashed costs more aggressively than those who started during economic booms. They also moved up within the company faster, stayed at the same business or within the same industry longer and adhered to a fixed managerial style even as economic conditions shifted. Overall, “recession CEOs” tended to generate higher returns on assets.

The paper may be downloaded for $5 but is free to Bureau of Economic Research subscribers, employees of the federal government and journalists. Begin by viewing the video presentation given by Schoar at a reunion of MIT graduates. The lecture runs for nearly an hour, but you can skip ahead to the 10-minute mark without missing much.

At the 14-minute mark, the presentation includes interesting statistics about how to and how long it takes to climb the corporate ladder. About 10 minutes later, Schoar describes how former military officers who become CEOs are less likely to get their firms into legal trouble. Since eco­nomic conditions influence how CEOs structure their company’s balance sheet, a paucity of managerial styles within the broader economy could emerge at certain times.

The study speculates that “If the majority of existing managers are brought up in a boom time there might be a net shortage of managers who know how to manage in a recession once the economic outlook changes.”

Since the irrational exuberance of the late 1990s was nearly 20 years into a period when little went wrong, that might explain why so many businesses were overleveraged when the dot-com bust struck. Alternatively, many current CEOs assumed their positions during the economic trials of the early 2000s, which could explicate why companies are sitting on piles of cash earning zilch.

So what’s the takeaway for investors from this intriguing research? Certainly, it’s not always possible to separate cause from effect. Yet the findings suggest that it can be helpful to study CEO backgrounds for clues about how they will manage a company. By itself, that information is insufficient to justify buying or selling a stock, but it does add an important piece of the puzzle in determining the investment worthiness of a business.

In her PowerPoint presentation, Schoar shows a New Yorker cartoon in which a therapist asks a patient, “Is there a history of recession in your family?” It’s a question investors might endeavor to find out about CEOs as well.